The potentially larger AIG problem

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UPDATE - Wednesday, 2:22 p.m. - Sen. John McCain targets the money to foreign institutions.

Why did we give $20 billion to foreign banks as part of the AIG bailout? I opposed it then, and I oppose it now,” he wrote an hour ago on his Twitter account.

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UPDATE - Wednesday, 12:23 p.m. - Senate Minority Leader Mitch McConnell took to the floor of the Senate this morning to denounce the Treasury Department for allowing billions “out the back door and into the pockets of the people who got AIG into this mess.”

Here’s the full statement as sent to me by McConnell’s office:

“Here’s a company that’s been taking billions and billions of dollars from taxpayers in the middle of what could be the worst economic downturn since the Great Depression. Now we hear that those taxpayer dollars were going into the front door, supposedly to keep the company afloat, then right out the back door and into the pockets of the people who got AIG into this mess.

“The Treasury Department was supposed to be minding the store. It was Treasury’s responsibility to watch how these funds were used. Obviously, they fell asleep on the job. Well, they need to wake up. Americans are fed up with their hard-earned tax dollars going to the people who got us here. They deserve to know how this happened. And the Administration and the Treasury Department needs to assure the American people that this will never happen again.”

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UPDATE - Wednesday, 9:30 a.m. - Former New York Attorney General Eliot Spitzer wrote about this as well yesterday.

“The appearance that this was all an inside job is overwhelming. AIG was nothing more than a conduit for huge capital flows to the same old suspects, with no reason or explanation,” Spitzer wrote.

 

 

Spitzer has this list of questions that he said should be “answered in public, under oath, to clear the air”:

 

1. What was the precise conversation among Bernanke, Geithner, Paulson, and Blankfein that preceded the initial $80 billion grant?

 


2. Was it already known who the counterparties were and what the exposure was for each of the counterparties?


3. What did Goldman, and all the other counterparties, know about AIG’s financial condition at the time they executed the swaps or other contracts? Had they done adequate due diligence to see whether they were buying real protection? And why shouldn’t they bear a percentage of the risk of failure of their own counterparty?


4. What is the deeper relationship between Goldman and AIG? Didn’t they almost merge a few years ago but did not because Goldman couldn’t get its arms around the black box that is AIG? If that is true, why should Goldman get bailed out? After all, they should have known as well as anybody that a big part of AIG’s business model was not to pay on insurance it had issued.


5. Why weren’t the counterparties immediately and fully disclosed?

 

“Failure to answer these questions,” Spitzer said, “will feed the populist rage that is metastasizing very quickly. And it will raise basic questions about the competence of those who are supposedly guiding this economic policy.”

 

In fact, many think those competence questions are already in play, and have been for some time.

 

 

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The political hue and cry over the millions in bonuses for AIG execs has hit fever pitch but there are major questions about what AIG has done with far larger portions of the federal bailout money it’s received over the past year than the $165 million in bonuses given to derivatives traders.

AIGdisclosed on Sunday night that it has given over $100 billion (with a B folks) — more than half of the $173 billion in federal dollars — to other financial institutions and state municipalities.

The Wall Street Journal this morning characterized this as money-laundering by the U.S. government to surreptitiously give aid to foreign-based financial institutions, such as Societe General, the France-based European financial services company, which has received $11.9 billion from AIG since last September.

“Given that the government has never defined ‘systemic risk,’ we’re also starting to wonder exactly which system American taxpayers are paying to protect. It’s not capitalism, in which risk-takers suffer the consequences of bad decisions. And in some cases it’s not even American. The U.S. government is now in the business of distributing foreign aid to offshore financiers, laundered through a once-great American company,” the Journal wrote.

“The politicians also prefer to talk about AIG’s latest bonus payments because they deflect attention from Washington’s failure to supervise AIG,” the editorial said.

Jim Rickards, a very knowledgeable financial expert who currently works at Omnis Inc., explained that there is a straightforward economic reason for all this money flowing through AIG to other institutions, but added that this is a huge political problem for the government.

AIG, Rickards said in an e-mail, “had trades with counterparties (Goldman, Deutsche Bank and many others) which, over time, produced paper profits for the counterparties and paper losses for AIG as market prices moved against AIG.  In that situation, it is customary (and contractually required) for the losing side (AIG) to pay the winning side (Goldman, others) the amount of the paper profits in cash.”

“This protects the counterparty against the possibility that AIG might not be around to perform when the trade is finally closed out at maturity. The name for this is a ‘margin call’ with margin being the name for AIG’s paper losses which have to be made good,” Rickards said. “So, when the U.S. gave AIG money, the money went right out the door to meet margin calls.”

“AIG was not much more that a conduit for government money which really went to the counterparties. So, in effect, the U.S. was not just bailing out AIG, it was bailing out the counterparties. Many were foreign banks which is part of the outrage,” he said.

You can see the whole list of companies that have taken AIG money, and how much, by clicking here.

And there are questions about why Goldman Sachs, the investment bank that has employed past Treasury Secretaries such as Henry Paulson (Bush) and Robert Rubin (Clinton), has received about $13 billion after saying last fall that it didn’t need any help.

Steve Clemons at The New America Foundation alleges a serious problem for Paulson and Rubin, but I’m not sure exactly what the allegation is. Or rather in the case of Clemons’ allegation that Paulson knew last fall that Goldman was in bigger trouble than it was saying, I don’t see any hard evidence for this.

“Rubin and Paulson have had major conflicts of interest that make Tim Geithner’s tax manipulations while an IMF employee look pathetically insignficant. Tom Daschle’s rides in a town car, Killifer’s failure to pay taxes on domestic help, and others who have avoided government because of the very high hurdles Obama has set for those who join his team simply pale in comparison to what we have learned about Bob Rubin’s ties to Citibank, Goldman and the Treasury; Hank Paulson to both Treasury and Goldman — and which have implications as well for their chief acolytes Lawrence Summers and Timothy Geithner,” Clemons writes.

“AIG and Goldman both lied about their positions last September. And Hank Paulson and other major financial elites involved in the AIG bailout knew it also,” he says.

Sam Jones at The Financial Times has his eye on this as well.

— Jon Ward, White House reporter, The Washington Times

Follow me on Twitter // jward@washingtontimes.com // Read my latest articles here // My YouTube channel

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